Lessons for directors from Mainzeal decision

The liquidators of Mainzeal Property and Construction Ltd (Mainzeal) scored a significant win this week when the High Court released its decision finding the directors of Mainzeal, including Dame Jenny Shipley and Richard Yan, liable for reckless trading. The Court ordered the directors to pay $36m to Mainzeal. MinterEllisonRuddWatts acted for the liquidators in the proceeding.

Case summary

The liquidators had argued that the directors breached their duty under s 135 of the Companies Act 1993 (reckless trading) because they had caused or allowed Mainzeal to trade for years with a significant negative balance sheet, therefore placing its creditors at substantial risk of serious loss.

Cooke J agreed. He ruled that Mainzeal’s parent company, Richina Pacific Limited (a company incorporated in Bermuda and controlled by Richard Yan) (Richina Pacific), extracted funds from Mainzeal by way of loans through intermediary group companies that did not themselves have the ability to repay. As a result, Mainzeal was balance sheet insolvent as early as 2005. Ultimately, these loans were not repaid despite Richina Pacific making substantial profits by using Mainzeal’s money to acquire valuable assets in China.

Using its authority as Mainzeal’s holding company, Richina Pacific required Mainzeal to follow an insolvent trading policy. Mainzeal’s trading performance throughout the relevant period had been poor. Nevertheless, the directors permitted Mainzeal to continue trading using money owing to sub-contractors as working capital in reliance on Richard Yan’s assurances that parent support would be provided if needed.

Cooke J found that the verbal assurances provided were conditional and not legally binding. The availability of support was also subject to stringent limitations on fund transfers out of China under Chinese regulations.

The judgment

For these reasons, the Court found that the directors caused or allowed Mainzeal to undertake business in a manner giving rise to a substantial risk of serious loss to the creditors, being the very loss that eventuated in the company’s liquidation. The Court imposed personal liability on the directors for 30% of that loss, amounting to $36m in round terms.

Our view

The proceeding has attracted considerable attention in the media and the corporate governance community. It is a timely reminder that, although directors will not automatically be liable for continuing to trade a company in an undercapitalised state, adopting a policy of trading while insolvent may attract personal liability for reckless trading.

Directors of companies within corporate groups need to carefully consider trading risks in much the same way as companies that stand alone. Reliance on assurances of financial support given by other companies in the group, in the absence of enforceable undertakings of real substance, is not reasonable and may expose directors to personal liability for reckless trading.